WASHINGTON, July 16 (UPI) -- In "The looming pensions crisis" March 13 I discussed the problem of defined-contribution pension plans, which became seriously under-funded in 2001-02, resulting in a requirement for additional pension contributions at a difficult time and in a looming actuarial crisis for the Pension Benefit Guaranty Corporation. Wednesday Steven Kandarian, Executive Director of the PBGC, spoke at the National Economists Club, so I was able to obtain an update on how things had progressed since March.
Set up in 1974 under the Employee Retirement and Income Security Act, or ERISA, PBGC receives premiums from defined benefit pension plans, which are used to fund deficits on plans of companies that file for bankruptcy. The program was in deficit for 21 years, from 1974 to 1995, yet survived because an actuarial deficit in pension liabilities does not result in an actual cash deficit until the liabilities have to be paid out in cash to pensioners.
From 1995 to 2001 PBGC was in surplus, its surplus peaking at $9.7 billion in 2000 -- the booming stock market, and a decline in under-funding problems at companies going bankrupt combined to cause this. Then in 2002, its surplus disappeared and was replaced with a deficit of $3.6 billion, the largest ever in nominal terms, which increased to $5.4 billion in the first quarter of 2003. (PBGC's fund has $31.4 billion in benefit liabilities and $26 billion in assets.)
There is however a much larger funding problem for the majority of defined benefit pension schemes, those run by companies not currently close to default. PBGC's estimate of the total un-funded liability in these schemes in 2002 is $300 billion, far exceeding the previous peak of about $120 billion in 1993. Kandarian pointed out that the rules on funding pension schemes are extremely lax, because of corporate lobbying at the time of 1974, 1987 and 1994 legislation, so that companies do not have to make pension contributions to schemes that are fully funded, and can take account of actuarial funding deficits over a period of several years. Not only does this deficit increase when the stock markets drop, but it also increases when interest rates drop, so that in 2000-2003 its rate of increase has been exceptional, and its current level is truly alarming.
Currently, approximately 63 percent of defined benefit pension funds are invested in equities. On the other hand, insurance companies which offer similar plans have approximately 87 percent of their fund invested in fixed income securities. Since the obligations of a defined benefit pension fund are bond-like -- they are predictable many years in advance, and do not depend on the state of the overall economy -- it would be much sounder for company pension funds to be invested primarily in bonds.
Under current legislation, there is a conflict of interest between pension funds and the management of their sponsoring companies. In bull markets, when the pension funds become fully funded, the companies are able to take a pension fund holiday, or even accrue the notional return of their pension funds based on some benchmark, which generally depends on the returns achieved previously. Thus when the stock market is strong, the theoretical minimum size of the fund (as distinct from the fully funded size as calculated by the PBGC, which depends on the long term Treasury bond rate) diminishes, and the company is able not only to stop making pension fund contributions but to accrue phantom income based on the fund's previous strong performance (and therby collect stock option profits for management.)
Once the stock market weakens, the company then has to resume funding its pension plan and, if the plan is heavily under-funded according to the PBGC calculation methodology (and many plans are less than 50 percent funded at current stock prices and interest rates) it must make top-up contributions, of course just at the time when its business can be expected to have weakened. This is particularly a problem because the overall number of non-contributing beneficiaries in defined contribution plans in 2002 came to exceed the number of contributors; thus the ability to make catch-up contributions is often constrained. In some of the steel company pension funds that fell to PBGC, for example, the beneficiary to contributor ratio was more than 5 to 1.
Of course, allowing funding holidays in good times and requiring top-up funding in bad times is both economically pro-cyclical and damaging to the interest of pensioners, as well as dangerous on the long run to the U.S. taxpayer because of the existence of the PBGC. Hence true pension reform (which we do not appear likely to get) might permit the company to take a funding holiday in bull markets, but would not allow it to accrue the result to income, instead forcing the company to recognize the missed funding as a deferred liability. Then if in some later year the pension plan became less than fully funded, it would have a first call on this deferred liability as additional top-up funding, in addition to the funding for that particular year.
Such a reform would prevent company management from artificially boosting its earnings in good years, while eliminating the earnings "hit" in bad years from sudden resumption of pension fund contributions. It might deflate the artificial bubble reputations of such as GE's former chairman Jack Welch, since GE would no longer be able to show a spectacular increase in earnings through milking its pension fund. More important, it would ensure that GE's pension fund was properly funded in bad times as well as good, and prevent the whole mess from descending on the U.S. taxpayer.
The current proposal before Congress would replace the 30 year Treasury bond rate (alleged to be "obsolete" though I fancy it is about to return because of the huge Federal deficits) with a corporate bond rate, thus raising the interest rate used in actuarial calculations and thereby reducing the nominal level of under-funding. In my view, this would be damaging unless the rules for funding pensions are tightened up, so that contribution "holidays" cannot be used to boost net earnings, and chronically under-funded plans have to be brought back to full funding on a more timely basis.
This is yet another problem that was exacerbated by the stock market "bubble," the period of lax ethical standards in management that accompanied it, and the artificially low interest rates that have followed. It is not going to go away, and may very likely cost us all a huge amount of money in topping up the PBGC. Damn you, Alan Greenspan!
